Modern Portfolio Approach

Until the 1950s, investors in countries wtih developed capital market the number of securities thought that the increase on the number of securities in the portfolio can reduce the portfolio risk. However, a positive or negative correlation among the returns of securities could not be considered. Harry Markowitz in 1952 published “Portfolio Selection” in his essay which has investigated how the maximum return of the securities in the portfolio can provide at a certain level of risk by taking into account the relationship among the returns of securities. Thus, Harry Markowitz’s portfolio theory pioneered the modern approach. Markowitz suggested reducing the non-systematic risk without being a decline of the expected return by collecting the securities whose returns are not full and positive correlation in a portfolio and examines of the associations among returns of securities on an investment portfolio.

One of the basic and most important assumptions of the Markowitz model is the efficient frontier (efficient portfolio) concept. The portfolios on the efficient frontier is the highest returns for a specific risk level or the lowest risk for a particular level of return. Markowitz has proved that portfolios on the efficient frontier could be determined by the way of “quadratic programming”. However, the set of efficient portfolios are needed to identify the various inputs (KaraĢin 1987). These inputs:

  • The expected returns of the N number of securities likely to be included in the portfolio.
  • Variances or standard deviations of the N number of securities likely to be included in the portfolio.
  • The covariance coefficients value can be classified as the number of [N (N-1)] / 2 indicating that the relationship between the returns of other securities and returns of each of securities.

Markowitz model is a laborious and expensive model thus the “Index” model which is a simpler model than Markowitz model has been developed by William Sharpe (AteĢ 2001, pp.48). After 1952, William Sharpe, John Lintner and Jan Mossin continued studying on portfolio management. The most important development in this direction is “CAPM” (Capital Asset Price Managemet). When investors investment in securities, particularly stocks according to modern portfolio approach, they are investigated that prices will change in which direction by using this model. There have been more extensive investigations since 1970 and the model has been tested by Richard Roll and Steve Ross. In same years, Roll and Ross took out the inadequacy of this model and the Arbitrage Pricing Model ” have developed.

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